Some Timberland Transactions and Other Stuff

I've had several requests for an update on issues surrounding timberland investments and transactions to date for 2011 so I am posting a chart of the transactions of which I am aware. I will also make a comment or two on conservation easements and on who is

More Thoughts on Foreign Investments in Timberland

My last post generated a couple of comments that referenced FIRPTA (Foreign Investment in Real Property Tax Act) and the likely impact that the law would “keep Asian demand in U.S. timberland muted”. The law has been around since 1981 so I thought that I would take a look at what the impact of foreign investment on timberland has been to date.

At last weeks Timberland Investment Conference, Stephen Schrock with Manning, Morris & Martin, discussed the Agricultural Foreign Investment Disclosure Act which requires “Foreign investors who buy, sell or hold a direct or indirect interest in U.S. agricultural land must report their holdings and transactions…” Agricultural land includes timberland as well. Penalties for not reporting can be very severe (25% of the fair market value of the land). The USDA Farm Service Agency compiles the data and produces an annual report summarizing the data.

Two comments from the summary of the current report:

• “Forestland accounted for 59% of all foreign held agricultural acreage…”
• “Foreign holdings of U.S. Agricultural land were relatively steady from 1999 through 2006; between 2006 and 2007, there was a significant 3.6 million acre increase and between 2007 and 2008, there was an increase of 1.4 million acres. Between 2008 and 2009, there was an increase of 1.3 million acres.”

The total numbers can somewhat mask what has happened with timberland alone but the graph below tells the story pretty clearly.

Trends in Foreign Holdings of Agricultural Land by Type of Use For the Period 1999-2009

I have to interpret the graph as saying that FIRPTA may have an impact but that it certainly does not prevent foreign investment in U.S. timberland. You can read the entire report here.

So that’s the past. What does the future hold?

From my own personal experience, I can assure you that there remains a strong foreign interest in U.S. timberland by both European pension funds and Asian investors. I suspect that the acquisition of pulp and paper mills by the Chinese will continue and I suspect a few sawmills will get thrown into the mix too. And I can’t imagine that the option of vertical integration of pulping operations is not on the table and that timberland ownership will not be the result. Is that good or bad for us? Ask the employees of the pulp and paper mills in Woodland, Maine, Halsey, Oregon and Potsdam, New York. The Asians supply the capital and the markets and we get the jobs. It might not set well at first blush but that’s a reversal of the way things have been and that’s not such a bad thing.

And remember, as we have seen domestically during the past year, all investors are not institutional or industrial! There are some very large investments coming from the high net worth individuals and families that have changed the market. We MAY be on the edge of another significant change in the ownership of U.S. timberland and whatever implications that may bring. --Brian

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Visit my Timberland Strategies web site

A BRIEF TIMO BACKGROUNDER

In discussions with newcomers considering investments in timberland or the publicly traded timber REITs, I frequently find that there is substantial misunderstandings about what a TIMO is and what the TIMO role is in the investment community. This backgrounder is intended to answer those questions. For a much deeper understanding of TIMOs, here is a link to an outstanding and in depth report prepared by Cliff Hickman with the U.S. Forest Service. It was prepared in early 2007 so some of the numbers are out of date but, other than that, it is the best researched report on TIMOs and REITs that I have seen.

What is a TIMO?

A Timberland Investment Management Organization. Note that the first word is timberland, not timber as it is so often written. There is a big difference. Timber refers to trees, timberland is land with trees on it! Many news articles in well-known financial news publications (WSJ, Barron's) have confused the two in recent years, which has led to significant confusion surrounding pricing and values of timberland. The second key point is that TIMOs do not own land; they buy land, manage it and sell it for their clients. They have teams experienced in both forest management and portfolio management. For this advice and service, they charge a fee.

Some history…

During the 1980’s, institutional investors began recognizing the value of adding timberland to their portfolios. By the early to mid 1990’s, there was a call by many analysts in the investment community for the pulp and paper companies to monetize their timberlands to reduce debt. More favorable federal income tax rates and accounting policies applied to the TIMO’s clients than the pulp and paper companies, which made the timberland more valuable for the former compared to the latter. Growth of the TIMOs was rapid as investors sought to acquire timberland and the pulp and paper companies sought to dispose of it. The companies that did not sell their land generally converted to the REIT form of corporate structure to provide higher after-tax returns for their shareholders.

Who are the TIMO’s clients?

They are large institutional investors with a focus on financial objectives, many of which are tax exempt. Specifically:

• Pension funds
• Public retirement systems (CalPERS, the California public employee retirement system, was one of the first and largest timberland investors). European pension funds invest in U.S. timberland also and U.S. funds own timberland in other countries.
• Corporate pension funds
• University endowments (Harvard and Yale were among the first institutional timberland investors)
• High net worth individuals and families
• Hedge funds
• Foundations

Note that the clients are all large investors.  The largest clients generally acquire land in separate accounts while some of the smaller clients participate in accounts with commingled funds. TIMOs are not structured to accommodate most individual investors (there are other good options for individuals though).

How do TIMOs differ from the so-called Timber REITs?

TREITs, or Timber Real Estate Investment Trusts, own the timberland, TIMOs do not. The publicly traded TREITs are Plum Creek (PCL), Potlatch (PCH), Rayonier (RYN) and soon to be Weyerhaeuser (WY). The tax structure for REITs allows the profits to be passed through to the shareholders avoiding the double taxation associated with the C corporations. That tax efficiency is why Weyerhaeuser is converting to a REIT.

How much timberland do the TIMOs manage?

The TIMOs manage approximately 25 million acres worth more than $30 billion. The three REITs (not counting Weyerhaeuser) own about 11 million acres worth about $15 billion. Including Weyerhaeuser, the REITs own about 17 million acres worth about $28 billion.

Who are some of the TIMOs?

Below is a list, in alphabetical order, of some of the largest TIMOs. All of them have web sites that you can google to get additional information about them.

• Conservation Forestry
• Forest Capital Partners
• Forest Investment Associates
• Forest Systems
• Global Forest Partners
• GMO Renewable Resources
• Hancock Timber Resources Group
• Lyme Timber Company
• Molpus Woodlands Group
• ORM/Pope Resources
• Resource Management Services
• RMK Timberland Group
• The Campbell Group
• The Forestland Group
• Timberland Investment Resources
• TimberVest
• Wagner Forest Management

Are there differences between TIMOs?

Yes. They have different investment philosophies that appeal to investors with differing objectives. For example, The Forestland Group invests primarily in natural forests, particularly hardwood. The Hancock Timber Resources Group puts an emphasis on forest technology to improve timber yields and financial returns. Some TIMOs focus on acquiring “conservation land” or land that can have “conservation easements” quickly sold and separated from the fee ownership. Some TIMOs have good information systems with strong financial controls and some do not. Some conduct field audits, some do not. Some have outstanding technical groups in-house, some contract it outside. Some manage the timberland themselves and some contract with consulting foresters. All of these issues should be weighed by investors and the right TIMO selected based on the objectives of the investor.

This post can be downloaded as a pdf here. Visit  the Timberland Strategies web site here. --Brian

Email: jbfiacco@gmail.com

The Trend in Timberland Prices

The current issue of Forest Landowners Magazine published an article that I wrote a few months ago that looks at the trend in timberland prices over the last decade. It examines the changes, data sources and some transactions during the first half of this year. It also tries to answer the following questions:

• What has caused timberland prices to stay up while timber prices and most investments have declined in value?
• What would cause prices to decline?
• So what does the future hold?

If you are interested in reading the article, here is a link to it on my web site. --Brian

The Dichotomy in Timberland Valuation

The issue in today’s post concerns why the transaction price of timberland has shown little or no decline in value but the stock price of the publicly traded companies that own timberland has declined dramatically. I will also look at what I think is happening in the timberland market today and how I see the market for timberland investment. But first, let’s set the stage.

In January, I did a post that included some graphs developed from my timberland transaction file. I was looking to see if the data supported a wide-spread belief that timberland values had dropped. The thinking was that housing starts declined, which caused a drop in lumber prices, which caused a drop in stumpage prices (all true), which caused a drop in timberland prices. You can read that post here How Much Did Timberland Values Fall in 2008? The data did not support the logic and did not show any evidence of a significant decline in timberland values. (For those that sent emails saying my opinion was wrong – that was not my opinion, it was just the data). I also wondered what the NCREIF Timberland Index would look like when it was released. The publicly accessible portion of the NCREIF website showed quarterly returns that compound to a 9.5% total return for the timberland in its index in 2008 but the components of the return are not broken out. A recent report by Brookfield Timberlands Management, distributed by Forestweb, shows the NCREIF return broken down by earnings and capital appreciation.

NCREIF TIMBERLAND INDEX

The significant decline in the blue portion of the graph reflects the decline in housing/lumber/stumpage/earnings. The green portion, Capital Appreciation, can be viewed somewhat (not perfect) as a surrogate of the change in timberland value as determined from tract sales and appraisals of tracts – all of which are a part of the index. Note the green from 2000 to 2002. This data certainly contains no indication of a 2008 decline in the price of timberland either.

Below is another graph that I found interesting. It is from the Timberland Report VOL. 10, NO. 2; by the James W. Sewall Company, a highly respected firm with a very long record in the timberland investment community.

From my perspective, the important take-a-way from this graph is that the old correlation between timberland values and housing starts fell apart. We can speculate as to why and we can speculate as to whether the correlation will return but it’s pretty clear that the conventional wisdom has not prevailed during this economic downturn. Another graph in the report reinforces the historical correlations between housing starts and stumpage prices. That correlation did hold as all timber owners know only too well. You can read the entire Sewall report here(recommended).

Now, let’s take a look at the price of common stock in some of the publicly traded companies that have timberland holdings that represent a significant share of the companies’ assets and see how share prices were impacted last year. Ownership structures of these companies include timber REITs, “C” corporations and limited partnerships but for my purposes today, I will refer to them collectively as “timberland companies”. Let’s look at this chart I made from Google.

It’s hard to see but the blue line just above Weyerhaeuser (green line) is the S&P 500. Weyerhaeuser took an early hit because it has such a major direct investment in housing. I read somewhere that it is the 17th largest home builder. The rest of the timber companies fell about the same amount as, and in synch with, the general market. My conclusion is that the timber companies stock price tracks the stock market rather than with the timberland market. Not a “pure play” in the bunch. Down about 50% when timberland prices held pretty steady.

I have long been a skeptic of the “pure play” concept of acquiring timberland companies (or an ETF) as a surrogate for timberland ownership. Even if 100% of the assets owned by the company were timberland, I would still be a skeptic and here is why.

Timberland investors use metrics based on a time horizon of 10 to 50 or more years. The key metrics are based on a discounted cash flow (DCF) analyses over that time horizon. If you would like to read more about timber valuation than you really want to know, you can do that here. The metrics used by those that analyze stock value are usually based on very short term future cash flows of a year or two (no need to discount those!). The inherent assumption is that the stock price will respond to very short term (a few quarters or few years at most) cash flows and that the stock will be bought or sold in that time frame. Some of the most referenced metrics are based on what happened last year rather than what is expected to happen in the future (current P/E for example). The Warren Buffets in the crowd that actually do take a long term view of stock investing are a clear minority today and I’m sure that DCF is an integral part of their valuation. Don’t misunderstand me. I’m not saying that one way is right and that the other way is wrong, only that they produce different results and that creates a dichotomy in value and an opportunity for long term investors. Given all this, is it any wonder that the stock of the timberland companies has fallen dramatically with the general market decline? The value of their timberland portfolio is based upon the very depressed earnings reflecting current stumpage prices rather than the DCF of future stumpage prices!

At this point, I reach two conclusions (and I know that some will not agree)

1. Timberland values have fallen little if any, and
2. The timberland value component of the timberland companies’ stock price has fallen dramatically

And therein is the opportunity.

Here is another stock chart just like the one above except Forestar Group has been added. If ever there was a pure play for timberland/HBU, this is it. Other than some OGM, that is its only asset!

The “Pure Play” Fallacy

In spite of that, the stock price of Forestar dropped over 80% - the worst of the group. So much for the “pure play” concept. If you want to invest in timberland, you need to own timberland, not stock!

Think about this. Is it possible that the assets of Forestar were worth five times as much in June as they were in November? Some folks sure didn’t think so. To name a couple, Holland Ware and Carl Icahn. Both recognize the dichotomy in valuation methodology between timberland and the valuation of the stock in timberland companies! Both made some serious money with that little bit of information and a lot of cash. Buy at $3 - $4/share, offer $15.00 (still undervalued), sell at $12 or so. Not bad. And the $15/share offer? Even that was well under the underlying value of the timberland/HBU asset.

Okay. We understand what happened in 2008. What is happening to timberland prices now and what will happen in the future? I still have seen no significant decline in transaction prices regardless of the emails I get claiming dramatic declines in prices (no transaction details attached). There is a slowing of transactions, at least one announced major transaction (St. Joe) did not close and several tracts that were put on the market were pulled off. What does this mean for the future?

It may mean that prices will fall. It may mean that buyers are holding their cash until this economic downturn, recession, depression, or crisis begins to resolve itself. I don’t know what the future holds but I do know that there is a lot of pension fund and other cash out there that will be invested somewhere. Today it is going into money market accounts and just kind of sitting there. Barron’s reported about a week ago that there was $4 trillion in money market funds which is about one-half the market cap of the entire U. S. stock market. That is a lot of money and I doubt that it will all stay in cash. At some point, some will go back into the market, some to commodities, some elsewhere and some to timberland.

Long term, I remain bullish on timberland but, in the short-term, I think that stock in the timberland companies is a better investment. The downside is less than timberland and the upside is much, much greater. If you follow Holland Ware, you won’t starve. --Brian
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Visit my website at Timberland Strategies
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Valuing Timberland V – The Discount Rate

This is the fifth and final post of a series on timberland valuation. If you missed the first post, which included an Overview plus a discussion on Disaggregation, you can read “Valuing Timberland I” here. The second post focused primarily on productivity and how that fits into today’s appraisal systems which use discounted cash flow techniques to determine the value of timberland. You can read “Valuing Timberland II” here. The third post focused on estimates of timber volumes and values, how we get them, and how to forecast them for future year’s cash flows. Read “Valuing Timberland III” here. The subject of the last post, Valuing Timberland IV, was on the methodologies used in discounted cash flow analysis. Today I’ll focus on the discount rate to be used in the cash flow model.

The “discount rate” is essentially the same thing as the interest rate used in any financial calculation. We have to get the series of future cash flows “discounted” back to the present so we pick the appropriate interest rate to do that. As an example, say you wanted to buy a tract of land and your credit union would lend you the money for 6%. You know there is some risk associated with this so you assign another 2% for risk. You would use a discount rate of 8%. Sounds simple to me.

Let me start off by saying “I don’t know what discount rate to use”! This question is argued by investors, economists and corporate finance types. But understand this, selection of the discount rate is the most important decision made during the valuation process. Let me illustrate.

Many years ago (I was working as a Land Acquisition Forester at the time) I decided to reread Thoreau’s “Walden” which led me to “In the Maine Woods”, “A Week on the Concord and Merrimack Rivers” and “Cape Cod”. Considering my job, Thoreau really got my attention with the following words from “Cape Cod”.

“Between the Pond and East Harbor Village there was an interesting plantation of pitch-pines, twenty or thirty acres in extent, like those which we had already seen from the stage. One who lived near said that the land was purchased by two men for a shilling or twenty-five cents an acre. Some is not considered worth writing a deed for.”

Thoreau had traveled across the Cape in the 1850’s and I had noticed and made mental note of these same pitch pine plantations while visiting there. So what would a Land Acquisition Forester think… “Man, what a buy that would have been!”

What if an investor knew what the values on the Cape would be like in 2008? Would he have bought some of that timberland for $0.25 acre? Maybe, maybe not. Let’s consider the opportunity and create a simple analysis. Let’s say that the investor could foresee all that wonderful HBU land on the Cape and actually KNEW what 2009 land prices would be like. Keeping it simple (so we can isolate the impact of discount rate selection), assume he leased the land out “for taxes” so he had no cash flows (positive or negative) other than the purchase and sale of the land. The data below shows the value of a $0.25/acre investment compounded forward for 150 years.






So…, would the investor have bought the land (for his descendents!!). It very clearly depends on the discount rate that the investor used. I don’t think that there is an acre of scraggly pine plantation on the Cape that could be bought for $1,562/acre and I doubt that you could sell an acre for over $300 million per acre either – not even the Kennedy compound. The value determined clearly depends on the discount rate used. So what discount rate would you have used? Think about that seriously. If the rate is too high (nice to get but will you get it!) you may never have the opportunity to make an investment EXCEPT one that is very risky.

When I was in forestry school (back in the 60’s) we normally used 6% in our forest economics courses. When I was an MBA student (in the late 70’s), we used the company’s marginal cost of capital with an appropriate adjustment for risk. Early in the timberland shift to TIMOs, it was pretty freely discussed that TIMOs were using real rates in the 6% to 8% which was based on the “risk free” rate of return (10 year T-bills at 4%) plus risk adjustment. At the same time, integrated forest products companies with large timberland acreages were using investment hurdle rates significantly above the average or even marginal cost of capital for the firm (a mistake – it should have been based on the marginal cost of capital and risk associated with purchasing and owning more timberland not riskier investments!). The result of this is that high-risk capital investments were subsidized by low-risk timberland ownership. As a general rule, discount rates used by the C corporations were much higher than that used by the TIMOs (rates in the range of 12% - 15% or more). Remember the decision you reached above with the Thoreau example. The C corporations also had to include taxes in the cash flow analyses (reducing cash flow and, subsequently, value) whereas most of the TIMO clients were pension funds and tax exempt. Between the tax payments and high discount rates used by the corporations, it is pretty clear why the TIMOs valued timberland higher than the forest industry.

Note two things from the above discussion. The “appraised value” of a particular tract of timberland, based on comparable sales, was the same for the TIMO buyer and the forest industry seller yet the real valuation for the buyer and seller were very different. As I pointed out in an earlier post; timberland valuation and fair market value are two different things!! The second point: the difference in discount rates used, combined with tax policy, has dramatically changed the face of timberland ownership and forestry practice in this country.

How do inflation and taxes affect the selection of the discount rate? We discussed that somewhat in the post on cash flows. Here are a couple of quotes, also from the Forest Landowners Guide to the Federal Income Tax, Ag. Handbook No. 718.

“it is imperative that the discount (interest) rate used for the analysis include a similar expectation factor for inflation. In summary, both elements of the analysis—cash flow and discount rate—must be kept in comparable terms (with or without inflation and before or after-tax) for reliable results.”

“Forestry investments are very sensitive to the discount rate used because of the long time period between planting and harvest. For after-tax analyses, the correct discount rate is the after-tax rate based on your alternative rate of return. If the next best alternative is a tax-free investment, such as a municipal bond, then the interest rate is used without adjustment, as shown in Table 2-3 for the 10-percent discount rate. If your next best alternative is an investment, such as a corporate bond, that yields 10 percent annually with taxes subtracted before compounding, the correct discount rate is 7.2 percent, after-tax [10 percent x (1 - 0.28 assumed tax rate)]. Alternatively, if the next best alternative is an investment such as an individual retirement account (IRA), certain saving bonds, or an alternative timber investment, where taxes are deferred until the end of the period rather than being subtracted before compounding, then the correct discount rate depends on the length of the investment period and when the costs are incurred and revenues received. Assuming an initial investment, 10 percent interest, and a 28-percent tax subtracted at the end of 34 years, the appropriate discount rate would be 8.94 percent.

Now, if you feel that you still need more info on how to select the right discount rate for a timberland purchase, let me give you a couple more references.

• “Timberland Investments” by Christian Zinkhan, et. al.
• “Discount Rates and Timberland Investments” by Brooks C Mendell in the Timberland Report published by James W. Sewall Company

Finally, it may be worthwhile to speculate a little bit (actually that is what the selection of the discount rate is). Timberland investors have watched as discount rates rose early in this decade followed by decreasing discount rates which resulted in a steady increase in timberland transaction prices (and corresponding values from comparable sale based appraisals). Some TIMOs have left the market so they clearly believe discount rates got too low and pushed prices too high (potential returns too low). Other TIMOs have tried to sell large blocks but pulled them off the market. Perhaps they think discount rates are too high but prices are too low to justify selling?? Or maybe there is less money chasing timberland. This concludes the Timberland Valuation series.

Oh, I almost forgot. Nobody is going to tell you what discount rate to use. That's your call. Comments welcome. --Brian

Valuing Timberland III

This is the third post of a series on timberland valuation. If you missed the first post, which included an Overview plus a discussion on Disaggregation, you can read “Valuing Timberland I” here. The second post focused primarily on productivity and how that fits into today’s appraisal systems which use discounted cash flow techniques to determine the value of timberland. You can read “Valuing Timberland II” here. Today’s post will focus on estimates of timber volumes and values, how we get them, and how we forecast them for future year’s cash flows. We will also take a quick look at the confidence you should place in them.

First, let’s look at timber volumes. What does the cruise say? What does the inventory say? What is the difference? How was the acreage calculated? Are volume estimates tied to a GIS? What are the sources of errors? Can volumes be reasonably audited? If the volume estimate isn’t “right”, the value certainly won’t be!

What is a “cruise”? A survey of forestland to locate timber and estimate its quantity by species, products, size, quality, or other characteristics; the estimate in such a survey. Several different sampling techniques can be used in a cruise. (source: Forestry Terms for Mississippi Landowners, Mississippi State University Extension).

What is an “inventory”? See Cruise (same source). H’mmm. I don’t want to aggravate my Mississippi State colleagues or to argue semantics but there is a huge difference between a cruise and an inventory or, more appropriately, a timber cruise and a forest inventory. To keep it simple, the cruise (as correctly defined above) collects data to estimate the timber volume, quantity, etc. that is there right now. The forest inventory collects much more information which can be used to project volumes and harvests (and other stuff too) into the future. A cruise, as defined above, wouldn’t collect any information on an eight year old loblolly pine plantation. There is little or no volume (perhaps a few trees that meet the limits of merchantability) but there certainly is value. A forest inventory would want to know the species, age, trees/acre, site index and acreage at a minimum. That is the information that is necessary to drive the growth and yield models necessary to estimate future wood flows from the tract. The wood flows become the basis for the cash flows in the appraisal. Perhaps this is just semantics but it is very important to understand the difference and to know what you are looking at.

So the “acquisition cruise” necessary to purchase land is more appropriately referred to as a forest inventory than a cruise. A “timber cruise” is more likely used to determine the immediate value of the timber for a timber sale. Data to drive growth models or cash flow models is not necessary. This distinction is more than academic. The inventory data can be “grown” to provide volume information for appraisals, stand level info for thinning or harvest, projected harvest and regeneration sites for planning site preparation and planting, all at multiple forward points in time. A typical cruise is not designed to do this. Merchantability specs are frequently different between cruises and inventories resulting in differences in volumes reported. Merchantability specs for inventories must be consistent from tract to tract, year to year, cruiser to cruiser and they must be consistent with what the growth models require. Merchantability specs for a timber sale cruise will normally be modified to conform to current demand, market pricing and perhaps even the logger that will be doing the harvesting.

The lesson here is that the user of cruise or inventory information had better understand what he or she is looking at. The cruise/inventory designer needs a clear understanding of the objective of the cruise. Otherwise, expect disappointment.

The sampling intensity of most inventories will not provide adequate data for timber sales. Inventories must collect some information on every stand or stratum (a collection of stands with similar characteristics). The objective of an inventory or cruise is to gather the information that is necessary at an acceptable level of accuracy at the least possible cost. Contrasting the two extremes, consider the case of a 100,000 acre land acquisition compared to a 50 acre mature hardwood timber sale. The objective of the land acquisition inventory is to be accurate enough to generate a reasonably accurate cash flow analysis for the perceived life of the investment (and hence, its present value). Another objective may be to assist in management if the tract is purchased. The resulting inventory would be one with a low sampling intensity but one collecting much information at each sample plot. The inventory is “not accurate” at the stand level. Cost is a serious consideration. If the tract is not purchased, the entire cost of the inventory is wasted. The 50 acre timber sale, on the other hand, has a much higher sampling intensity (perhaps a 100% tally), does not require collecting growth modeling information and requires careful inspection of the quality of each tree relative to current market conditions. The cruise cost/acre is much higher but the payback is immediate and ensured.

Statistics 101: Reiterating an earlier point when addressing timber volume reports; you had better understand what you are looking at. Most well done cruise reports will provide some detail with respect to the statistical accuracy provided by the data. You will see something like “2,216 MBF ± 10% of hardwood sawtimber”. This means, that from a statistical standpoint, the actual volume will be within 10% of the volume estimate 95% of the time, or maybe 90% of the time, or maybe 66% of the time. Maybe you better ask which probability level applies! You will probably also see a volume by species report and perhaps that will also provide statistical error reporting too. If it doesn’t, you should understand that because the sampling intensity for any given species is well below that of all of the species combined, the accuracy of the estimate drops pretty dramatically in a mixed species stand or forest. Now, digging into the cruise report a little deeper you will see that volumes may be reported by species and diameter class. How accurate do you think that will be? If the statistics are reported, that is great. If not, beware the value that you place in the numbers. This information can be useful but you have to assign it the appropriate credibility.

You should also understand that there are other sources of error in a cruise in addition to the statistical sampling error. Examples are the use of incorrect volume tables, measurement errors, poor sample design, calculation errors and, yes, a poor cruiser.

The statistical accuracy of large inventories that have been conducted over several different years and have been brought current using growth models is a different story. I’m not going to get into how to do this because I have no earthly idea how to do it! It can be done by a fairly limited group of forest statisticians, mensurationists and biometricians but it is clearly a difficult task. As a rule of thumb, it is safe to say that the accuracy is somewhat less than what would be calculated using the “ungrown” plots and declines as the number of “grown” years increases.

That’s enough said about cruise reports, inventories and the timber volumes that they report. Now let’s talk about volumes that what will be there tomorrow and the fundamentals of creating a future wood flow.

Future harvest volumes and timing must be done on a stand by stand basis utilizing stand volumes that have been “grown” using yield tables and growth and yield models. The starting base is the stand or strata level inventory and each stand or stratum is grown into the future. Some rule or methodology is then used to select the harvest date to determine the harvest volume for each future year. The result is a wood flow model that, when combined with values, becomes a key component of the cash flow model. More detail about this will be provided in the next post.

This is probably the appropriate place to discuss the integration of a GIS (Geographic Information System) with the timber inventory system when creating the information system used for timberland management. GIS based inventory systems are very common among managers of large tracts of timberland today and sellers normally provide output from these systems to potential buyers. Inventory or cruise volumes may say what is out there but the GIS says exactly WHERE it is on the surface of the earth. A quick check of the validity of the data provided by the seller can be made by auditing selected stands to compare inventory acreage, stocking, volumes, forest types, SI, etc. to the audited values. It doesn’t take much of this type of checking to determine how serious the forest managers have been about the quality and timeliness of their inventory efforts and hence the credence that can be placed in the data provided. The GIS data can be “read” into the GIS based harvest scheduling/ cash flow models and will eventually provide the basis for future management (activity schedules, maps and annual cash flow projections). These are the tools that become the foundation for communications and expectations between the new landowner and the timberland managers. The schedules tell the owner what to expect financially and form the basis of the management plan for the manager. A final point about the GIS based inventory system is that it provides the basis for a field audit in conjunction with the traditional financial audit. In the timberland sector, a financial audit without a corresponding field audit is a serious mistake; in fact, it's not really an audit.

Now let’s discuss timber values. They are down! A lot! If you are selling timber today, that is very important but how important is it with respect to timberland valuation? Should current market conditions be used for valuation?

The comments below are by Rick Holley (from Plum Creek 2008 Q3 Earnings Conference call) answering an analyst’s question about why he thinks timberland values are holding up while other asset classes are declining in value. The quote is a little messed up but his point is clear.

“I think largely because the investor in timberlands, and there’s still a fair amount of capital on the sidelines trying to invest in timberlands, is longer term. They’re looking through this cycle. If anything they’re starting to look at this cycle and lower prices as being more upside when you look out a year or two years or whatever these markets improve. I know there was a recent [Reese] article talking about some transactions that may or may not get done. We’re in the marketplace and we talk to a lot of buyers. We know who the sellers are, and we think all those transactions will in fact get done at very, very good prices, so I think the market is holding up and there’s still a lot of capital chasing very little opportunity…”

The key words above are “looking through…” with respect to timberland prices. To me, that implies that they are also “looking through” with respect to the timber values used in the timberland valuation. I think that if stumpage prices were at all-time highs, buyers would “look through” and see lower prices in the future as well. As Andy Malmquist, my good friend, former employee, and current TIMO guy, used to remind me about so many things… “It’s regressing toward the mean”! Andy actually talks like that.

There are at least three factors to consider for determining future timber values to apply to future volumes – current values, real price increases and inflation. We will discuss how to address inflation in the next post so for now, we will confine the discussion to the first two items.

I am defining “current price” as a “look through” price that is on the trend line for the species,local area and region (huge differences between NE and NW, cherry and red maple). In other words, I am looking for the price that has “regressed to the mean”. This data can be obtained from several different pricing services such as Forest2Market, RISI and Timber-Mart South. In addition, most state forestry commissions (South Carolina Forestry Commission pricing report) or forestry university extension services also provide some level of pricing reports. Local consulting foresters usually know what is available and can also provide first hand local knowledge. Pricing from these sources will provide the baseline for projecting the value of future harvests in the cash flow model.

A real increase in future stumpage prices can and should be incorporated into the model if you think it is justified. U. S. Forest Service reports suggest that sawtimber stumpage prices have increased at a real rate of 2% a year over a very long period of time. An analysis of southern pine stumpage prices by forest economist Jack Lutz reached the following conclusion:

“Our analysis indicates that southern pine sawtimber stumpage prices are mean-reverting, with a 50-year mean of $38.29/ton (based on LDAF data). Those prices have held to that mean through 50 years of timber supply and demand shocks and significant changes in timber harvesting and processing technology. That means we should not expect a significant increase in sawtimber stumpage prices in the near future. This supports the current practice of many timberland investors who are using 0% real appreciation rates in their timberland investment models.”

The future is anybodies guess but the real value increase used should be based upon your view of the future. That’s why there is always a high bidder and a low bidder!

This concludes the discussion on timber volumes and values. The next post in the series will attempt to tie it all together by addressing the methodologies associated with the discounted cash flow models. Comments are welcomed. --Brian

How Much Did Timberland Values Fall in 2008?

My stock portfolio has certainly taken a hit to the downside. The housing market has tanked and the values of many houses and rental units have gone down with it. Stocks of the publicly traded timberland owners have gone down 20 to 60% in the last year or so. The logic is that the decline in housing has caused a drop in lumber price which has created a drop in timber (stumpage) price which has resulted in a corresponding drop in timberland prices. So logically my portfolio has taken a hit on the tree farm side too. But has it?

I do some consulting with market analysts and hedge fund managers interested in valuing timberland and the drivers behind it. The most common question that I have heard recently surrounds the declining value of timberland and just how great that decline is. How can a company like Weyerhaeuser or Plum Creek be properly valued given the logical decline in timberland values? I could give my opinion (and I always do!) but that is not enough.

I have been maintaining a database of the major timberland transactions for over a decade so I wanted to quantify the change for 2008. Below is a chart showing the $/acre sale price trend for the last decade.


















This is pretty interesting. Nationwide, it appears that prices have dropped about 21% following a year where they gained 60%! BUT… it is important to understand the data and what is happening. This database is composed of transactions that total between one and seven million acres in any given year. Also in the database is a “REGIONS” field. Price distortion occurs between years due to the variation in the percentage of sales occurring between regions ($/acre varies significantly between regions). So how does the price per acre change if we just look at a single region? Let’s look at the South.



















Within any particular region, individual transactions will impact any given years weighted average price. In spite of that, the trend is clear and it is difficult to find any argument in the data that supports a decline in timberland pricing – at least in the South. The first reported sale for 2009, Potlatch to RMK, was at $1,745/acre, right in the ballpark.

The Northeast is the only region that did show a drop last year. The acreage sold in the NE was not particularly large (meaning most of the variability was probably due to the variability between tracts) so I would be reluctant to attribute much significance to the decline. There was one significant datapoint though. The Essex Timber to Plum Creek transaction (at $267/acre) pulled the average down. It is important to note that there was a conservation easement on this tract. We should expect to see significantly lower transaction values as more sales occur on tracts with existing conservation easements. The sale of a conservation easement provides revenue in the form of an early payment for HBU land but it can also have a negative impact on future forestry based revenues as well.

So…, what does all of this mean? I can see little or no decline in timberland values. I’ll be curious to see what the NCREIF index on timberland values has to say. The index is based more on appraisals than actual sales but the appraisals SHOULD be based on comparable sales and comparable sales just do not support a decline in appraisal values. If sale prices are not declining, what is wrong with the logic expressed in the first paragraph – declining housing starts means declining timberland values?

Here is my take. First, buyers are “looking through” current timber prices. Sophisticated timberland investors use appraisal techniques that look at cash flow from timber over the planned life of the investment. Those timber values are based on their view of the future, not just today’s market.

Second, more money is chasing fewer acres. A significant amount of timberland is being pulled from the market. Example: almost all of the 161,000 acres of Finch and Pruyn timberland in the Adirondacks will ultimately be withdrawn from production and become a part of the Forest Preserve. An example from the other side of the equation: this week the United Nations announced that its pension fund would diversify its portfolio and seek to acquire timberland. More money chasing fewer acres. Institutions want to diversify their portfolios, particularly by acquiring hard assets.

Third, future wood demand will be impacted by both renewable energy and global warming concerns. We are already seeing pellet mills being built to export pellets to Europe where they are mixed with coal to reduce the amount of carbon tax the utilities must pay. Most forecasters expect to see a similar tax in the U.S. soon.

Fourth, there is evidence that declining interest rates are impacting the discount rates used by institutional timberland purchasers. A declining discount rate drives value up!

These are my thoughts, these are my numbers, and these are my opinions. Comments are welcomed. --Brian

Timberland – Keep it or sell it?

I like to look forward and speculate about what is going to happen. Sometimes with a good analysis, sometimes with just a good guess. Either way, nobody can say that you’re right or wrong. Only time can do that. And it does.

But once in awhile it is good to look back. Maybe to say “I told you so” or perhaps to see just how foolish I have been with some of my prognostications. Either way, the value is in the looking.

About ten years or so ago the TIMO sector was starting to grow in earnest. It was clear (to some at least) that C Corp ownership of timberland was probably not the best ownership structure. The large timberland owners were all Integrated Forest Products Companies (IFPCs) and some had already been experimenting with different corporate structures such as LPs and REITs. Most were maintaining the status quo and capitalizing on TIMO investor driven demand by selling off their “non-strategic” holdings to generate cash or reportable earnings.

By 2000, the pulp and paper industry was about five years into some very bad times from a profitability standpoint. The investment community (and I know many of my readers are market analysts - so pay attention to this little trip back in time), had one mantra. “Sell your timberland and pay down debt”. The decade before that it was all about percent self-sufficiency. The higher the level of self-sufficiency (the more land owned), the more favorable the analysts view of the company. Mantras change abruptly.

Interesting discussions occurred in many offices during the two or three years before and after 2000. (“Let’s keep the land and sell the mills!” – Heresy!). Reactions to the analysts’ demands (or maybe to the poor profits) were varied. In some cases, corporate management bought into the analysts view, other managers explored and ultimately implemented the evolving REIT structure and one major company maintained the status quo. So who was right? Perhaps this chart will shed a little light on the issue.

Picking Weyerhaeuser as the major representative (about the only one actually) of the “status quo” decision makers, I’ve compared their stock prices to the REIT crowd (PCH, PCL and RYN) and the timberland divestures crowd (represented by IP, MWV and LPX) over the past five years. What does this tell us?

The status quo decision was right in the middle with respect to stock price performance.

An examination of the three timberland sellers (those that restructured based on the advice and pressure of the analysts) were all losers – some big time losers. Analysts pay attention. Your advice and pressure destroyed a great deal of shareholder value. But then again, it wasn’t your fault. The fault lies squarely with the senior management that took those companies down that course. The final chapter has yet to be written for these firms but it sure doesn’t look like the right decision at this point.

The shareholders of the three companies that saw the REIT opportunity and charted their own course through a complex and somewhat risky maze were very well rewarded relative to the others. All three of these companies actually acquired land over the five year period. What a difference is made by good strategic decisions on the part of senior management. History pins the Gold Medal on Rayonier’s senior management team. –Brian

Potlatch and Weyerhaeuser: Which Strategy is Best for Shareholders?

Weyerhaeuser and Potlatch are similar in that they are both major timberland owners and both have significant manufacturing facilities. Both are essentially integrated forest products companies but Potlatch is structured as a REIT and Weyerhaeuser is structured as a C Corporation. Both are publicly traded (and heavily owned by institutional investors) and both have been in the spotlight with respect to where they are going in the future. There has been pressure on Weyerhaeuser to convert to a more tax favorable REIT and criticism of Potlatch’s status as a timber REIT when so much of its assets and revenue have nothing to do with timber (not really a timberland play). The response of the two companies has been very different.

Yesterday, Potlatch’s Board approved the proposed split of the company into two separate companies - a pure timber REIT and a pulp-based manufacturing company. The REIT will be a true timber REIT with 1.7 million acres of timberland and will retain the Potlatch name. The spin-off, to be known as Clearwater Paper Corporation, will be a manufacturing company whose businesses had revenue of approximately $1.2 billion last year. Both will be publicly traded.

According to Mike Covey, "After a careful evaluation, our Board determined that separating these distinct businesses is a logical next step for Potlatch in our ongoing efforts to strengthen our businesses and build long-term value for shareholders. This strategic move will enable shareholders to have a direct stake in two unique companies - an essentially pure-play timber REIT and a solidly positioned pulp-based manufacturing company. This increased transparency will enhance the likelihood that each company will receive appropriate market recognition of its unique performance and potential. This action also recognizes the inherent diversity of our assets and the opportunities that will be available to both companies as independent businesses."

Covey continued, "This spin-off will enable the management and board of both Potlatch and Clearwater Paper to have a sharper focus on their core businesses. Additionally, as two standalone entities with sound operations and talented management teams, both companies will be better positioned to manage and grow their businesses, leverage their distinct competitive strengths, attract and retain key employees, and pursue value-creation opportunities such as acquisitions over the long-term."

Weyerhaeuser, on the other hand, has opted to maintain the status quo for at least a while longer. They have clearly been shedding manufacturing facilities in preparation for the “possible” conversion to a timber REIT but it is clear that they see no urgency. They have long had a business model that focused on growing and managing trees specifically for a particular product in a particular mill – and they have been very good at it. They have captured value. But… I think it is a dead model. The value gains from that model don’t appear, to me at least, to be as great as the tax efficiency gains from the REIT model. Many investors agree. Weyerhaeuser’s stock price has declined to about $50 per share.

One analyst estimated the timberland value alone at $60 per share. My estimate of the timberland value is significantly higher - about $80 per share. Weyerhaeuser’s management has always understood the value of owning high-site land and of the financial value of intensive management. And those two factors are keys in timberland valuation. Weyerhaeuser’s timberland is not “average”!

Longleaf Pine

If you read my Blog through email subscription rather than visiting the Blog site, you probably have forgotten the byline. So..., The Timberland Blog: Examining the changes in timberland ownership and what those changes might mean. The pulp and paper industry was very focused on maximizing growth as opposed to the financial return focused on by the institutional investors. Management objectives are a primary key to what the future forest will look like. That's fact.

Way back in '67 while working on a major cruise/appraisal for the West Virginia Pulp and Paper Company, I remember vividly a sign near Washington, Georgia that said “Wilkes County, Gone to Grass”. I was with friend and mentor Kenney P. Funderburke, who said wryly “the sign should say, Gone to Loblolly Pine!”. Times change, economics change, landowners change, management objectives change, the forest changes. Like Wilkes County, the South went from natural forest, to cotton, to pasture, to loblolly pine for fiber production to whatever is next. What is next? For some of the Southern forest, maybe a return to the longleaf pine that once dominated this landscape. Management objective of optimizing financial return permitting.
If you are familiar with the longleaf and loblolly, the comparisons jump into your head very quickly. Longleaf is straight. Loblolly is crooked. Loblolly grows faster (at least initially). Loblolly occupies a broader range of sites. Longleaf is straight.

The lower pulpwood prices, combined with a focus on financial return of the new owners, provides an opportunity for longleaf to reassert itself. Back in the days when the land was managed by Native Americans, the objective of management was to burn the forest to prepare it for agriculture, provide nitrogen fertilization, reduce ticks and chiggers, improve hunting, grow broomstraw for housing, and to be able to see enemies lurking in the forest. That's some pretty powerful reasons to burn. At that time, the EPA was less concerned with smoke, environmentalists were less concerned with pine monoculture, and there were fewer lurking lawyers in the forests. The point here, is that the longleaf forest was not “natural”, it was created by its managers based on the objectives of management. These managers created a pine forest of an estimated 60 – 90 million acres that was reduced to less than three million acres in 1996 by a series of landowners whose objectives were cotton, rice, beef, soybeans, and wood fiber production. If longleaf is to expand replacing some of the loblolly acreage, that expansion must fit with the objectives of the new management – that being financial performance as opposed to the fiber productivity objective of the pulp and paper industry. I think it can do it. So do the sawmilling families that have owned and managed the longleaf remnants for the past 75 years.

The fact that longleaf is so straight can go a long way in a comparative economic analysis. The Longleaf Alliance has some financial analysis on its web site which illustrates the gains from increased pole production and the increased value of the poles over sawtimber. I didn't notice the increase in proportion of sawtimber to pulpwood characterized by longleaf stands although it may have been there. The growth and yield models do show that loblolly's growth advantage diminishes or disappears as the rotation age increases. In addition, nursery and silvicultural improvements have reduced the amount of time it takes to get the seedlings up and out of the grass stage thereby reducing the rotation age and improving the financial performance of longleaf. At any rate, it looks to me like the economics are there, at least on some sites.

I don't want to forget us Family Forest owners. Collectively, we own a lot more of the former longleaf forest than the institutional investors by a long shot. And our “management objectives” are generally broader than those of the investment community. The Feds are working to help us understand and to put money in our pockets if we will convert to longleaf and do it their way. So far, it seems to be working with a couple of hundred thousand acres being planted each year. That's enough to turn the tide and longleaf acreage is actually increasing now. It may not be increasing much but at least the decline has been arrested.

So..., what does all this mean? We are in the early stages of a change in the South's forest which will in fact see more of the landscape revert to the beauty of the historic longleaf pine forest that defined the “pineywoods” of the Old South. There is something about longleaf that stirs the soul, loblolly doesn't. --Brian

ETF as Surrogate for Timberland Investment

In the Feb. 18th issue of Business Week, there is an article entitled "Wood Paneling for Your Portfolio". I'll start with a couple of quotes from the article and then I'll disect them.

"Buying timberland is one of the ways big guys running pension plans and endowment funds have diversified their holdings away from financial market trends and earned fairly stable double-digit returns to boot. But timberland has been mostly off-limits to individual investors, because it requires millions of dollars to buy in."

"Enter the Claymore/Clear Global Timber Index ETF. It's a new exchange-traded fund that invests in stocks of companies with the world's greatest exposure to timberland. It amps up the exposure by weighting the 27 stocks in the portfolio not by market capitalization but by actual acres companies own."

"This sort of everyman version of a timberland play..."

Okay, that's enough. I've been reading about this ETF as a surrogate for timberland ownership since its inception and I would like to say very LOUDLY and clearly that this is NOT a timberland play.

First, let's consider the above quote "timberland has been mostly off-limits to individual investors, because it requires millions of dollars to buy in." No it does not. Small tracts of timberland with all of the advantages of larger tracts are available for purchase. The use of a LLC allows investors to combine financial resources to acquire larger tracts. You can even purchase timberland within an IRA. Consulting foresters in all regions of the country are available to assist with appraisals and management. Many of these consultants are the same people assisting the institutional investors with timberland acquisition and management. If you want a timberland pure play, you will have to buy timberland and it is within the reach of most investors. If you want to get an idea of what is available for sale and pricing, just do a Google search on timberland for sale or consulting foresters in your geographic area of interest. If you want to learn more about buying small tracts of timberland, you might want to buy and read Curtis Seltzer's "How To Be a DIRT-SMART Buyer of Country Property". There is a lot of info in it that can put you on the right road. Before you buy, you will still need a consulting forester or someone else very familiar with timber values, land productivity and the local market. If you want to delve into the concept of timberland as an investment, I'd recommend "Timberland Investments" by Chris Sinkhan, et. al. which is pretty much the classic in that field.

So, no, you don't need "millions of dollars" to buy timberland!

Now let's look at the Claymore/Clear Global Timber Index ETF and see why it is not an "everyman version of a timberland play". To be fair to Business Week, they are not the only ones promoting this ETF as a surrogate for owning timberland. I have seen at least a dozen articles with similar comments.

Below is a list of the holdings in the Clear Global Timber Index along with the percentage weighting of each. As you scroll down through the list, ask yourself the following questions.

• Is the primary asset of this company timberland?


• Does this company own any land or has it sold its timberland?


• Is the stock weighting in the portfolio "by actual acres companies own" as claimed in the article?


• Is this company forced to acquire its timber on the open market (or at market price if there is a fiber supply/lease agreement)?


• What level of fiber self-sufficiency does this company have?


• Does this company grow and sell more timber than it uses?


• Is this company the exact opposite of a timberland play?


• Is this index/ETF more reflective of the global pulp and paper industry index than timber or timberland?
  

Clear Global Timber Index
Top Fund Holdings as of 2/13/08

Name/Weight
INTERNATIONAL PAPER CO/5.48%
VOTORANTIM CELULOSE E PAPEL SA/5.46%
ARACRUZ CELULOSE S.A. ADR/5.17%
POTLATCH CORP/4.86%
SINO-FOREST CORP/4.83%
RAYONIER INC/4.78%
SVENSKA CELLULOSA AB-B SHARES/4.77%
SAPPI LTD/4.74%
TIMBERWEST FOREST CORP/4.61%
PLUM CREEK TIMBER CO INC/4.60%
WEYERHAEUSER CO/4.60%
SUMITOMO FORESTRY CO LTD/4.56%
HOLMEN AB SER B/4.55%
MEADWESTVACO CORP/4.49%
GUNNS LTD/4.45%
OJI PAPER CO. LTD./4.33%
SMURFIT KAPPA GROUP PLC/4.28%
GRUPO EMPRESARIAL/3.76%
CHINA GRAND FORESTRY RESOURCES/3.22%
DELTIC TIMBER CORP/2.71%
WEST FRASER TIMBER CO LTD/2.67%
HOKUETSU PAPER MILLS LTD/2.48%
GREAT SOUTHERN PLANTATION/2.13%
CANFOR CORP/1.25%
TIMBERCORP LTD/1.21%

If you answered the questions, it should be very clear that this index is NOT a timberland play but in many cases, it is just the opposite. For example, as timber and timberland prices increase, you would expect the value of the index to increase as well. Here is a quote from MeadWestvaco's news release following its last quarter.

"Higher input costs for wood ...negatively impacted profitability."

The corporate structure of many of the key holdings above is very similar to that of MWV. This ETF may be a good investment, I can't say, but it is certainly NOT a surragate for timberland ownership. It reflects a global pulp and paper play.

So..., is it possible to invest in stock as a timberland play? Maybe, kind of, in a way. At a minimum, we can do a heck of a lot better than this ETF. We'll do it by creating a basket of stocks from the above list that really are backed up by timberland and that have little or no exposure to pulp and paper. Let's also eliminate the bulk of the foreign stocks which, to a degree, have currency exchange risk associated with them (You may think that the dollar will continue to decline so they will be a good investment but that is not timberland investing, that's currency investing - then again, you might think that the dollar is about to turn around...).

Let's start by putting check marks by Plum Creek, Potlatch and Rayonier. All have significant timberland acreage, little or no exposure to pulp and paper, and a tax efficient corporate structure (REIT). The timberland in these three stocks provides plenty of geographic, species and market diversity. That diversity substantially reduces many of the risks associated with both timberland and stock investing. I believe that this basket will come as close to owning timberland as you can get. If you want to add a few more, consider Deltic Timber (timberland and lumber mills), Pope Resources (a MLP), and Weyerhaeuser (six million acres but pulp and paper, lumber mills, currency risk, and inefficient tax structure). Weyerhaeuser is a particularly interesting addition because its current market cap is less than estimates of the timberland value. In addition, a probable change in the tax structure will likely result in a significant increase is share price. So let's create a basket with three to six of these stocks and forget the ETF. It will be more reflective of a timberland investment.

But remember, too, that it is NOT timberland. It is stock - be that good or bad. On the positive side, the stock basket is much more liquid than a timberland investment. The stable, continuously rising value of timberland will be absent. Daily values will change with the stock market. Value will rise and fall with major market influences like housing. Quarterly profit will impact the stock price (no matter how foolish). Last week an analyst reported that Potlatch was a better buy than Plum Creek. I checked the stock prices for the two of them and Potlatch was up about 3.5% and Plum Creek was down by 3.5%!!! The value of the timberland at neither company had changed one penny but the difference in value of the two companies was 7%! These types of moves may be foolish but they are also reality.

So..., this may raise a couple of questions in your mind. First question: How can we do a better job at selecting stocks to "kind of" mirror timberland investments than a professional investment firm like Claymore? Answer: Due to laws and regulations that apply to mutual funds and ETF's, they are restricted from taking a position that exceeds 5% of the fund. That means that they must take a bare bones number of 20 different companies in the ETF and there are not 20 companies out there that even approach being true timberland plays. We win not because we are better but because we are blessed with more flexiblity.

Second question: How could Business Week's assesment be so far off? Answer: ?? --Brian

Investing in African Plantations

A new firm, Arfwood Timberland Partners LLC, has been launched with the stated purpose of investing "in African timberlands specifically investments in: African Plantation forests companies, African Farm forests companies, African eco-tourism companies, African certified forest products retail companies, and African carbon sinks establishments. "

It is unclear to me if the proposed investments are just in African companies or if they will actually be investing in plantation and natural timberland as well. The following is an extract from their promotional literature. --Brian

__________________________________________

say YES to investments in:
 African Plantation Forests
 African Farm forests
 Africa Eco-tourism
 African certified forest products retail
 African Carbon sink establishments

AFRWOOD TIMBERLAND PARTNERS LLC is a for profit perpetual timberland investment firm registered in the State of Delaware USA, specializing in Africa with power to secure the market by investing in local retail outlets. The company will invest in African plantation forests, African farm forests, African eco-tourism, African certified forest product retail outlets and African carbon sink establishments. The firm is managed by African wood Inc, and may take on any number of additional managers depending on need. The partners, who must be qualified investors in their jurisdiction, should be able to commit a minimum of five million United States dollars in patient long term investment funds since the managers cannot guarantee an exit route in the medium term.

For Commitments and inquiries contact: David F Amakobe, President, African Wood Inc, Suite 902, One commerce Center, 1201 north Orange street, Wilmington, Delaware 19801,

T. 302-884-6737, F. 302-884-6738, Skype: afrwoodusa, www.linkedin.com/in/fundingafrica , www.afrwood.com

Weyerhaeuser Takes First Step toward REIT

In a news release today, Weyerhaeuser's actions confirms that it will evaluate the possibility of converting to a REIT.
*******************************************************
Weyerhaeuser Considers Strategic Alternatives for Containerboard, Packaging and Recycling Business
FEDERAL WAY, Wash., May 4 /PRNewswire-FirstCall/ -- Weyerhaeuser Company (NYSE: WY) today announced that its board of directors has authorized a process to consider a broad range of strategic alternatives for its Containerboard, Packaging and Recycling business. Alternatives range from continuing to hold and operate the assets to a possible sale or combination. Read the entire news release.
********************************************************

Analysts have been pushing WEYCO to convert to a REIT in order to gain a more favorable tax rate for its timberland operations. WEYCO has resisted because of laws prohibiting such a move for companies with large manufacturing bases such as Weyerhaeuser. Removing the above mentioned business units from the timberlands operation will pave the way for conversion to a REIT. If this should happen, it will clearly be in the best short term interest of shareholders. It also means the end of the most successfully integrated "from forest to end profuct" company in history - MAYBE not a good thing for long-term WEYCO investors. But change happens and my feeling is that nobody, not even Weyerhaeuser, can stop the tide.

Weyerhaeuser has great people, great forest management, great timberland and will make a great REIT!

Auditing Timberland Silvicultural Activities

This is a sensitive subject but it needs surfacing. It applies to all organisations that are subject to financial audits. Many, perhaps most, financial audits of timberlands operations are pretty much worthless and provide a false sense of security. An effective audit of their revenue/expenditures for activities such as timber sales, site preparation, tree planting and road construction must have four components to have any level of credibility. They are:

1. the convention financial audit
2. a report of activities showing the pertinent information by an I.D. number (sale, stand, activity, etc).
3. a map with corresponding I.D. numbers
4. A field audit that verifies that what is on the ground is consistent with what has been reported. (i.e. stand 1521 is actually 156 acres of loblolly pine and is stocked reasonably close to the reported level).

So..., if you have an investment in timberland, did your forest managers audit meet these requirements for both revenue and expenditures. From my experience, there are three requirements necessary to make this happen.

First, the senior manager team must include foresters so there is a solid understanding of what is happening on the ground. You would think that this would be a given but it is not true in all TIMOs.
Second, a management information system capable of reporting those activities (the report) and capable of saying exactly where the activity took place (the map). This requirement is generally met in the form of a Geographic Information System.
The final requirement is a management team willing to make it happen. This type of an audit can expose weaknesses in even the best of organisations. Properly executed, these audits will not only assure investors but will also form the basis of improved operations.

When I was with the Forest Technology Group (responsibilities included both development and sales of webFRIS at various times) I had the opportunity to see the information systems of many forestry companies, TIMOs and state forestry organizations. In the process, I also noted a huge difference placed on the value of solid information by different organisations. The organisations with the best systems wanted even better systems. Some organisations had virtually nothing and little interest in obtaining the type of system required for adequate timberland management. If there were no foresters in key roles, there was little priority placed on good information systems or field audits. And I am convinced that those in charge did not recognize their vulnerability. The long term nature of forestry investments has the capability of masking poor management control. But sometimes, the chickens do come home to roost.

There is an alternative to a willing management team - an investor that requires it. As President Reagan put it - "Trust but verify".

Increasing Investor Interest in Timberland

If you have been watching the stock price of the timber REITs for the past few months, you should have noticed some pretty dramatic gains (way above all market indices!). Plum Creek went from about $34 into the low $40's. When they announced lower earnings and a less than optimistic outlook, the stock price barely hiccuped. Potlatch is up. Rayonier jumped. In fact, during the last 30 days when the S&P jumped about 1.5%, PCL, PCH, RYN, TIN, WY, & JOE are all up from 6% to 12%! What's happening?

Private investors are looking for the pure timberland play but it's hard to buy a tract of timberland (at least in a knowledgeable manner). And that timberland is not too liquid either but a share of one of the above companies is. And private investors with the big bucks have the same thing in mind. Example: Carl Icahn moving heavily into Temple-Inland.

On the institutional investor side, the demand for timberland just keeps building and getting more competitive as more institutional investors recognise timberland as an asset class in itself. What started with institutional investors here in the U.S. is now spreading world-wide at a pretty fast pace. Here is an interesting article that illustrates the increased interest by investors in Europe. All told, there is a lot of money chasing timberland with no outlook on the horizon suggesting that the demand will decline anytime soon.

The Most Important Change...

in timberland today is clearly the shift in ownership from forest industry to TIMO's, government and NGOs. I have heard many comments suggesting that the shift to TIMOs is a bad thing but, if we believe in capitalism and free markets, then we have to think otherwise. Good or bad, though, is like beauty - its in the eye of the beholder. One person would think that all of the IP lands that went to the Nature Conservancy was a great change. A mill owner needing hardwood sawlogs might not think it was so good!

But one thing is for sure, things will be different and that is not just in the eye of the beholder. Let's throw out for thought what some of those changes might be. First, what about productivity of the land from the perspective of forest products. There is a lot that goes into this ranging from silvicultural investments to the length of ownership. The forest industry's ownership horizon used to be to own timberland "forever". Not so for TIMOs which normally have a relatively short time horizon and factor in the value of "flipping" HBU (Higher and Better Use) lands at the time of acqusition. I once bought a tract of land in Mississippi at a very favorable price because the owner felt that if he sold to a paper company he would never have to worry about having neighbors close by because the land was sold for building lots. Those days are gone. TIMOs are clearly more likely to capitalize on the HBU lands than industry did historically. This pulls forest land out of productivity (not a bad thing, just a fact).

Recently while attending a Tree Farm meeting I was listening to comments about how the TIMO sales of HBU lands to homeowners and hunters was creating a serious forest fragmentation issue which I suppose is somewhat true. What wasn't said is that these sales are also creating a wonderful opportunity to bring many more people into the Tree Farm System and to add to the political strength of those owning Family Forests. So there are pros and cons surrounding fragmentation.

Productivity is greatly impacted by silvicultural investments, particularly in young stands. I'm not sure how TIMOs compare to forest industry on that issue. I know some TIMOs that practise very intensive forestry and some that do minimal work and just hope the value increases. There is a big difference between TIMOs. But guess what - there was/is a big difference between companies in the way industrial land was/is managed. I'm not sure what or if there is a net difference.

In the area of basic research and developing and implementing technology, the TIMOs clearly fall down. The historically long term view of industrial firms is absent with the shorter time horizons of TIMOs and basic research is gone. TIMOs seem to be very good at implementing proven technology if, and only if, the gain will show up in the next annual appraisal. Forest research must come from academia and government in the future, right? Maybe not. Capital markets will come to the rescue and provide the technology needed (you do have faith in capitalism!). As industry disposes of its nurseries and research wings, a new industry will emerge to provide those products and services (we are already seeing it develop) and my guess is that the new industry will deploy its capital more efficiently that has been done in the past.

Now let's think about fire control. As industry has sold land it has also disposed of, or significantly scaled back on the fire fighting assistance that it has provided to state fire control organizations. When the largest timberland owner in the U.S. sold its lands to TIMOs and NGOs, the seller no longer needed fire control equipment and its pretty safe to say that the new owners had little interest in maintaining fire control personnel or equipment (somebody tell me if I'm wrong!). Now, what about our faith in capitalism and the thought that capital will flow to meet this need. Perhaps the faith is misplaced here and these new buyers (TIMOs, NGOs, Tree Farmers, homeowners, hunters. etc) need to step up to the plate and provide very strong support for funding of state forest fire control organizations. That means through both lobbying and increased taxes on forestland focused 100% on improved fire control. This will not happen until after a major calamity. In the meantime, state fire control budgets will shrink (in real dollars) as government finds "better" places to allocate its expenditures.

So..., what's the net change in productivity as a result of all these changes? My guess, and that is all that it is, is that productivity goes down mainly as the result of a decline in productive acreage. That's bad. Or is it. Pulpwood demand has dropped significantly in the U.S. so maybe the productivity decline will be a good thing. Or maybe we will come to understand that people would rather eat than have gasoline made from corn ethanol. Or see timberland and wildlife habitat cleared for corn fields. Perhaps soon a President will wake up to the fact that he/she has a nation with forests capable of providing ethanol (and other forms of fuel) and a very capable research team already in place that is capable of making it happen. Then forest productivity will once again be a major issue and timberland investors will be smiling. And capital will flow to forest research! and to silvicultural expenditures! and to fire control! But that's a thought for another day. --Brian